Stocks have ventured into correction territory, falling by approximately 10% from their peak in the late days of July. This downturn has been fueled by the resurgence in long-term government bond yields, the horrific carnage of the Israel-Hamas war, and renewed worries of an economic recession.

Equity retreats of about 10% or more (the definition of a correction) aren’t uncommon and they can be healthy, because they restore equilibrium and provide buying opportunities. But many on Wall Street are suddenly expressing the fear that the correction could be a prelude to a drop of 20% or more, i.e. a bear market.

To borrow Halloween terminology…perhaps something wicked this way comes. Have we witnessed a run-of-the-mill correction, or the early stages of something worse? Let’s examine the validity of these fears and how you should trade now.

Boo! Wall Street’s jump scare…

In Hollywood, a sudden out-of-nowhere shock in a horror movie is called the “jump scare.” (Remember when you first saw Mrs. Bates’ desiccated corpse in a rocking chair in Psycho?) Investors were startled out of complacency last week, when stocks fell more than 2% across the board and the S&P 500 crossed the threshold of a correction (see table).

The CBOE Volatility Index (VIX), which is known as the “fear index,” is flirting with 20, a reading that denotes greater stress and anxiety in the markets.

However, I see glimmers of hope, as strides in inflation control and resilient growth within key areas of the economy provide reassurance that this current pullback will not lapse into another bear market.

Of course, rising crude oil prices (an inflationary trend), and turmoil in the Middle East and Eastern Europe (as well as turmoil in Washington, DC), are all converging to create a highly uncertain investment backdrop. Additional jump scares could be in the script.

The U.S. could experience a federal government shutdown next month, as the divided House of Representatives continues to resemble a stage production of “Lord of The Flies.”

However, investors should steady their nerves. I advocate a strategic approach, one that embraces opportunities to integrate quality investments at more modest price levels.

A renewed pursuit of 5% in the benchmark 10-year U.S. Treasury yield was the main catalyst for the S&P 500’s slump last week to its lowest point in five months.

The technology mega-caps have largely beaten earnings expectations on the top and bottom lines, but anemic forward guidance has in some cases shaken Wall Street’s confidence. Since mid-October, bellwether tech stocks have underperformed and the broader stock market has been caught in their undertow.

A V-shaped economic recovery in 2024 probably isn’t in the cards, but a recession appears unlikely as well. Indeed, the prospect of a U-shaped recovery remains viable.

The full repercussions of previous Federal Reserve interest rate hikes have not yet reverberated through the economy, but consumer spending and jobs growth continue to show durable strength. The economy remains on solid footing, which obviates a full-blown bear market.

The initial government estimate suggests that U.S. gross domestic product (GDP) advanced at an annualized pace of 4.9% in the third quarter, surpassing expectations and more than doubling the rate of the preceding quarter. The engine behind this robust growth was consumer spending, which remains the bedrock of the economy.

Economic softness might materialize in forthcoming quarters, but deceleration is unlikely to be strong enough to torpedo stocks. The enduring strength of the labor market and consumers’ financial stability, relative to historical standards, are likely to bolster consumer spending for the foreseeable future.

About 70% of the U.S. economy is comprised of consumer spending. The strength of the impending holiday shopping season will provide a crucial clue as to the stock market’s prospects in the new year.

Inflation remains on a path of moderation, despite robust growth and low unemployment. The core personal consumption expenditures (PCE) price index, the Fed’s preferred inflation gauge, inched down to 3.7% in September from 3.8% in the preceding month

Although this PCE reading still exceeds the Fed’s 2% target, it represents a considerable reduction from last year’s peak of 5.6%. I anticipate further abatement in inflation due to decelerating wage growth and diminishing housing-related price pressures.

The FOMC’s big meeting this week…

It’s widely expected that, at its meeting October 31-November 1, the Fed’s policy-making Federal Open Market Committee (FOMC) will maintain interest rates at their current levels. This expectation of a pause is partly influenced by the recent upswing in long-term bond yields, which reduces the need for additional rate hikes.

Historically, the period following a Fed pause has generally been favorable for the markets, with stocks experiencing substantial gains in five out of seven instances between the final hike and the initial rate cut, with only two modest declines recorded (in 1987 and 2001). Additionally, bonds have historically delivered above-average returns in six of these seven instances (see chart).

The trajectory of bond yields is approaching a potential peak. The abrupt ascent of the 10-year Treasury yield to 5%, a level not observed in 16 years, has exerted pressure on equity valuations and bond prices.

Though pinpointing the precise moment remains challenging, yields may be nearing a cyclical zenith. This expectation is predicated on the anticipation of three factors: moderating economic growth, a shift by the Fed towards rate cuts in 2024, and inflation converging towards the Fed’s 2% target.

Investors were handed a pre-Halloween treat on Monday, with the main U.S. equity indices closing higher as follows:

• DJIA: +1.58%
• S&P 500: +1.20%
• NASDAQ: +1.16%
• Russell 2000: +0.63%

It was the Dow’s best day since early June. Wall Street has grown optimistic that interest rates are near a peak, with CME Group’s FedWatch Tool on Monday putting the odds of a Fed pause this week at 98.2%.

When the U.S. central bank finally stops siphoning liquidity from the markets, we’ll stand a better chance of seeing a sustainable bull market.

Read This Story: A Look at Q4 and What Lies Ahead for 2024

I believe we’re on the cusp of sector rotation. In early 2024, it’s likely that the year’s worst performers, e.g. defensive stocks such as utilities and real estate investment trusts (REITs), will probably bounce back the most.

Among the publications that I edit is our premium trading service Utility Forecaster. My colleague Robert Rapier is the chief investment strategist.

Do you seek peace of mind in today’s uncertain investment climate? As you position your portfolio for next year, turn to utilities stocks. These stable, high-dividend stalwarts provide shelter from the storm. Utilities stocks offer growth, income and asset protection. That’s an unbeatable combination.

But you need to pick the right ones. For our list of the highest-quality utilities stocks, click here now.

John Persinos is the editorial director of Investing Daily.

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